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The Diverted Profits Tax


By Tax-News.com Editorial
September 11, 2017


Earlier this year, global beverages company Diageo turn out to be the first company to become ensnared in the United Kingdom's new diverted profits tax (DPT) net. With tax experts predicting that it will be far from the last, this article provides and outline of the controversial levy, its potential impact, and similar taxes being considered, or legislated for, in other jurisdictions.

The Diverted Profits Tax – An Overview

The DPT, which took effect in April 2015 as part of the 2015 Finance Act, is intended to counter aggressive tax avoidance by multinational companies. It is charged at a rate of 25 percent (compared with the current corporate tax rate of 19 percent) on all profits "artificially" diverted from the UK. It is a separate tax to corporation tax, and as such cannot be set off against corporate tax liabilities.

The DPT operates through two basic rules.

The first rule counteracts arrangements that exploit permanent establishment rules. In particular, the DPT applies in cases where a person is carrying on activity in the UK in connection with supplies of goods and services by a non-UK resident company to customers in the UK, provided that the detailed conditions are met.

The second rule intends to prevent tax advantages obtained through the use of transactions or entities that lack economic substance. The primary function is to counteract arrangements that exploit tax differentials and will apply where the detailed conditions, including those on an "effective tax mismatch outcome," are met.

Multinationals are required to inform HM Revenue & Customs (HMRC) if they potentially fall within the scope of the DPT. The legislation provides that, where a designated HMRC officer determines that the DPT should apply, a preliminary notice would be issued explaining, among other things, the reasons for the amount of the charge and the basis on which it has been calculated (including the details of the amount of the taxable diverted profits).

The recipient would then have 30 days to make representations. The designated HMRC officer may consider certain specified matters within a further 30-day period before either issuing a charging notice on the original or a revised amount, or confirming that no charge arises.

Where specific conditions are met and the designated HMRC officer considers that certain expenses otherwise deductible may be greater than they would have been at arm's length, the diverted profit charge will initially reflect a 30 percent disallowance of those expenses. The charging notice will require the payment of the DPT within 30 days. Penalties will apply for late payment.

Following the due date for payment, there is a 12-month review period during which the charge may be adjusted based upon evidence. At the end of the review period, the business has the opportunity to appeal against any resulting charge. The review period can be brought to a conclusion earlier with the agreement of both parties. There will be no postponement of the disputed tax during the review period or due to any subsequent appeal.

HMRC released updated guidance on the application of the DPT on November 30, 2015.

The updated guidance is divided into five chapters. Chapter 1 provides an overview of the new regime, and Chapter 2 sets out key information about the application of the DPT legislation, including the detail of the conditions which must be met; examples of the situations to which it applies; and the computation of diverted profit.

Chapter 3 contains information about the ways in which taxpayers affected by the application of the DPT could "engage with HMRC in an open and transparent way."

Guidance about the computation of the tax, including the availability of credits and its interaction with other taxes, is contained in Chapter 4. This Chapter also includes information about notification, assessment and payment, including interest, penalties, and appeals.

Finally, Chapter 5 sets out the procedures that HMRC has to follow to impose a charge, including governance procedures.

HMRC advises that the guidance should be read in conjunction with the legislation, Explanatory Notes, and the Tax Information and Impact Note released on March 24, 2015.

Impact Of The DPT

It is early days in the life of the UK DPT, and therefore it is difficult to judge the law's effectiveness. However, the wide scope of the tax, combined with HMRC's determination to police the DPT regime rigorously, is expected discourage the more aggressive end of corporate tax planning on the one hand, but lead to more disputes on the other. Commentary and observations from both tax experts and HMRC staff certainly point to these outcomes.

As Andrew Scott, a tax expert at Pinsent Masons, observed last year, HMRC is deploying considerable resources to enforce the new diverted profits tax.

Scott said in comments for Pinsent Mason's Out-Law site. "It is very interesting to see the view from the top at HMRC on the application of the diverted profits tax. It is clear that the scope of the tax is wide and it is also clear that the resources given to HMRC to assess DPT issues are being effectively deployed. This is bound to result in HMRC seeking to explore in depth with taxpayers whether a DPT charging notice should be issued. As the tests rely so heavily on questions of fact, it is vital that taxpayers engage in full fact-finding and present the evidence to HMRC in as cogent a way as possible to support their arguments."

Interestingly, Jim Harra, Director-General of Business Tax at HMRC, suggested that while taxpayers are deploying more conservative tax strategies, they can still expect to defend their tax positions on a regular basis.

"There has been a significant reduction in appetite on the part of big business from engaging in avoidance and aggressive boundary pushing... But we won't necessarily see a reduction in the amount of tax in dispute," he told the paper.

Indeed, the experience of Diageo, which strongly denies any DPT liability, would seem to bear out Harra's thoughts. And while this is said to be just the first DPT assessment made against a company by HMRC, it could be just the first of many.

UK The DPT Trend-Setter?

Thus far, it seems there has been little appetite for similar types of tax elsewhere in the world. This could be because the DPT falls outside the specific recommendations of the OECD's base erosion and profit shifting recommendations. Or it could simply reflect the view that DPTs are considered bad tax policy.

Nevertheless, Australia recently followed in the UK's footsteps by introducing a DPT earlier this year, and France was in the process of legislating for such a levy before the measures was struck down in court. New Zealand has also given consideration to a diverted profits tax as part of its BEPS response.

The Australian DPT

Australia's Diverted Profits Tax (DPT) entered into force on July 1, 2017, under which multinationals found to have artificially shifted profits overseas will face a 40 percent tax on the diverted profits.

The DPT applies to multinationals with an annual global income of AUD1bn (USD790m) or more, and Australian income of more than AUD25m a year.

The Government expects the tax to raise AUD100m a year from 2018-19.

According to Revenue Minister Kelly O'Dwyer, "if a multinational company does business in Australia, it will pay tax in Australia."

She said the measure "will force companies to change their behavior in terms of their tax arrangements in Australia leading to more tax being paid on income earned in Australia."

The DPT applies to income years that start on or after July 1, 2017. It can apply to schemes entered into before that date.

Broadly the new law will apply if under a scheme, or in connection with a scheme:

  • A taxpayer has obtained a tax benefit in an income year;
  • The principal purpose, or one of the principal purposes, is to obtain an Australian tax benefit or to obtain both an Australian and foreign tax benefit; and
  • None of the following tests apply:
    • the AUD25m income test;
    • the sufficient foreign tax test; or
    • the sufficient economic substance test.

France

France appears to be the only other country to attempt to legislate for a diverted profits tax. However, the Government's efforts were thwarted late last year by the country's Constitutional Court.

According to the ruling, made by the court on December 29, 2016, the method by which the French tax authority would apply the diverted profit tax was insufficiently detailed in the legislation and therefore gave the tax authority too much discretion in a company tax audit.

As a result, the provision violated Article 34 of the French constitution, which stipulates that statutes must determine "the base, rates, and methods of collection of all types of taxes."

Based partly on the UK diverted profits tax, it would have allowed the tax authority to impose corporate tax on profits deemed to have been artificially diverted from France with the intention of avoiding tax, irrespective of whether the company was established inside or outside of France.

The tax was due to be introduced on January 1, 2018.

New Zealand

In New Zealand, there remains some uncertainty as to whether a DPT will be introduced, due largely to the Government's ambiguous statements on the matter.

Last year, New Zealand's Cabinet said a Diverted Profits Tax was not then its "preferred option" for tackling base erosion and profit shifting. However, a Cabinet paper released in December 2016 stated that: "While the current preference is not to adopt a DPT, we have not ruled it out."

"If following consultation on the discussion document (or at any other time in the future) we consider that our proposed package would not be effective in addressing transfer pricing and permanent establishment avoidance, we will revisit the adoption of a DPT," the paper said.

"While [a DPT] is likely to achieve greater taxation of these profits, it could impact on perceptions of the predictability and fairness of New Zealand's tax system for foreign investment," the paper added.

However, New Zealand's Labour Party, the country's leading opposition party, has said it would introduce a diverted profits tax on multinational companies if elected.

 

Tags: tax | Tax | Australia | France | New Zealand | legislation | tax authority | business | court | interest | multinationals | law | tax planning | transfer pricing | United Kingdom | tax avoidance | corporation tax | penalties | services | audit | Finance

 

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